Reading 18, Asset Allocation Question 17, LSC’s pension plan. Did anyone else notice an inconsistency in the answer? The question asks to choose an allocation most appropriate for the pension plan, only one sentence: “Select and justify the portfolio that is most appropriate for LSC’s pension plan.” In the question stem, the IPS for the pension plan says: “The portfolio should focus primarily on investments in businesses directly related to our main business to leverage our knowledge base.” They are a tech company, so it would make sense to choose the portfolio with the highest Sharpe and a substantial investment in IPO/Tech (40%), which is Portfolio B. However, the solution says: “Portfolio C is the only appropriate choice. It is well diversified across all asset classes with minimal IPO/technology exposure , and only 34 percent of the portfolio exposed to the riskier asset classes in total (IPO/Tech, small-cap growth, and venture capital). IPO/Tech assets may be highly correlated with the plan sponsor’s underlying business, thereby exposing both the company and the plan beneficiaries to excessive risk in the event of a sharp downturn in the company’s business.” I understand the rationale in the solution but it is out of context because we should assume that unless otherwise stated, one should invest according to the IPS, not what CFAI thinks is correct. Am I missing something?
Im recalling from memory but this specific example the company’s IPS was under review by you and you’re supposed to give recommended changes to the IPS that decreases the overall risk of the pension plan.
These questions are intended to be read as though you’re the PM/analyst/advisor, so this is the CFO coming to you as the advisor. He’s giving you an IPS that was created by Eileen Jeffries and the firm’s president so you need to critique whether or not it is appropriate and develop a new one (if the existing IPS isn’t good) prior to selecting the portfolio.
The IPS developed by Eileen and the president is pretty weak. A good IPS per CFAI, should fully list out the objectives (RR) and constraints (TTLLU). So, given that it’s a weak IPS, we should also critique the assumptions in it. In addition to being incorrect about having the plan’s investments be highly correlated to the performance of the business, we can also note that the IPS does not list a specific percentage as a return requirement. Additionally, it does not call out ERISA under the legal constraints.
Ultimately, we need to recognize that this IPS is garbage and incorporate the CFAI curriculum to reach their solution.
Hope this helps.
Thanks for your responses, Madajaha and Galli.
I think this question must have had parts cut and pasted from other questions, but weren’t put together correctly. I went back to it, and the only people mentioned were Donovan, the CFO, and Eileen Jefferies who is the President (no advisor mentioned). They also referred to Eileen as a “he” which just adds to the mistakes IMO. Anyway, I’m gonna let this one go and will be looking out for other LSC questions in the EOC problems.